2/1/16: Don't miss that Urals spread

Over recent months, I have been highlighting the importance of considering, when it comes to Russian economy and Ruble analysis, not just quoted spot prices for Brent grade oil but also the Brent-Urals spread.

At last, some media (in Russia) is catching up: Падение спроса на российскую нефть и сильный доллар не дают рублю укрепиться - http://invst.ly/ocwh.

30/12/15: 2016 Better Be Kinder to the Old Ruble... or...

The never-before mighty Ruble started the last day of 2015 trading on a shaky ground:

And it ended the year on a shaky ground:

And for all the pain, there is little gain. As oil tanks, Ruble will keep sinking. Per recent report from Bloomberg (emphasis mine):

"The currency would need to tumble more than 20 percent to at least 90 against the dollar to tip the
country into a full-blown crisis, according to 17 of 20 respondents in a Bloomberg survey. Should such a threat emerge, the Bank of Russia has an array of tools at its disposal, including verbal and market interventions, an emergency interest rate increase and capital controls, they said. “It would take more than 90 rubles per dollar to provoke significant repercussions,” said Sergey Narkevich, an analyst at Promsvyazbank PJSC in Moscow. “In 2015, Russian monetary authorities managed to mostly avoid spillovers from the foreign currency market and keep the financial system afloat and broadly functional.”

Except, here's a problem, per BAML:

Source: Bloomberg

Now, connect the dots... At above 90, we will have 'significant repercussions' and oil is already at around 37. What is more, all of the above references Brent prices. But Urals-Brent spread has been pretty awfully 'unfair' to Russian energy suppliers, and with the glut of eager and ready substitutes producers in the markets, the spread is unlikely to improve. Which means that 'above 90' can be 91 or it can be 95 or it can be 88... go figure.

Then again, may be, by some miracle, the New Year will be a happy one for the Ruble.

Update: Russia is hardly unique in linking currency valuations to budgetary / exchequer balances, as argued in this post - all commodities-dependent economies do that. And there is, of course, that added dimension of recessionary pressures, as shown in the chart below (taken from Bloomberg article covering Chinese growth woes):

17/12/15: Re-aligning Ruble with Oil: Fed Hiccup...

Two casualties of the Fed's rate jitter: Oil & Ruble

Source: @Schuldensuehner 

Ruble is now nearing August 2015 lows on a continued trend that realigned with oil prices.

And while we are at it, another pairing:

Source: @Schuldensuehner 

Note: as of yesterday's closing Russian CDS 5 year spread was at 308.91 with implied probability of default of 19.15%. A week ago, same stood at 291.64 with implied probability of default at 18.26% and at the end of Tuesday, at 305.91 with implied probability of default at 18.99%.

But as a reminder, watch not only Brent, but also Urals-Brent spread. Hawkish dove of the Fed has less to say on that than Russian energy substitution ongoing in Europe and Turkey via Saudi's and Iranian contracts.

8/12/15: Commodities Rot Runs Ahead

Commodities rot continues unabated, as Bloomberg Commodities Index fell to its lowest reading since June 1999:

Source: @Schuldensuehner

Which, of course prompted another repricing of the commodities-linked currencies:

 Source: @Schuldensuehner

As I noted few days ago (post here) for the Russian Ruble, there is some room to the downside from here on.

Here is an interesting discussion of the historical trend/cycles in commodities busts via Carmen Reinhart: https://www.project-syndicate.org/commentary/commodity-price-decline-will-continue-by-carmen-reinhart-2015-11. And long-view chart of same:

Trend-wise, that is 160 years of deflation...

5/12/15: Ruble converging to Urals... at last

After some strengthening in the second half of November, Russian Ruble continues to re-align with oil prices:

With current levels of Urals-Brent spread, Ruble has room to the downside still, at about 2-3 percent, taking it into 69.8-69.9 range. Which means the CBR has some room for raising foreign exchange reserves, but not much room...

10/11/15: First Anniversary of Ruble's Free Float

1 year old 'free-float' Ruble to USD and EUR:

It has been pretty breathtaking ride to revaluations and a baptismal by fire. And amazingly non-exciting world of CBR interventions:

12/9/15: Russian Exports & Trade Balance for July

Central Bank of Russia released latest figures (for July 2015) covering external trade in goods. Here are some details.

Russian exports of goods (in US dollar terms) fell 40.15% y/y in July following a 25.6% drop in June. These are not seasonally-adjusted figures, so we can only do y/y comparatives. The drop was sharper for Russian trade with countries outside the CIS (down 42.35% in July) than with CIS countries (down 'only' 22.71%). This implies a reversal in June changes when exports to CIS countries fell more substantially than exports to non-CIS countries (-30.46% and -24.76% respectively).

Taking out some monthly volatility, 3mo average for Russian exports of goods were down 32.15% y/y in May-July, with distribution of declines pretty much even across both CIS and non-CIS states (-32.19% and -32.15%, respectively).

Russian imports of goods fell even more than exports in percentage terms. Russian imports of goods fell 41.87% in July in y/y terms, having previously posted a decline of 38.3% in June. 3mo average through July 2015 was down 40.19% y/y.

However, in level terms, declines in exports were sharper than declines in imports: 3mo average through July 2015 for exports was down USD14.04 billion against decline in imports of USD10.99 billion.

As the result, Russian trade balance (goods only) deteriorated sharply in July 2015, declining 37.21% y/y in July, having previously posted a relatively small decline of 1.24% in June. On a 3mo average basis through July 2015, trade balance in goods was down USD3.041 billion compared to the same period in 2014 (-18.66%). On 3mo average basis, trade balance with CIS was down marginally USD802 million in value terms, but sharply in percentage terms (-29.3%), while trade balance with non-CIS states was down sharply in both levels (USD2.24 billion) and in percentage terms (-16.5%).

As chart above shows, the contraction in July Trade Balance was very sharp. To see this, consider historical series for Russian Trade Balance in goods since January 2000:

July 2015 y/y decline in overall Trade Balance for goods ranks as the sharpest since July 2009 and 13th sharpest decline since January 2000.

CONCLUSIONS: Overall July drop in Russian Trade Balance (goods only) was driven primarily by lower energy (oil and gas) prices and deterioration in Ruble valuations (Ruble is down some 15% since July 1).

As a related note, as reported by Bloomberg earlier this month, despite another strong harvest, Russian exporters of wheat are being held out of the global markets by the Government measures aimed at curbing food inflation at home.

3/9/15: Russian Manufacturing, Services & Composite PMIs: August

Russia PMI data for Services, Manufacturing and Composite posted sub-50 performance across all three indicators in August, returning the economy back to where it was around June 2015, and erasing the fragile expectations of stabilisation that were based on July data.

As noted in my analysis of BRICs manufacturing PMIs earlier (link here):

Russia Manufacturing PMI fell to 47.9 from 48.3 in July, marking 9th consecutive month of sub-50 readings and worst performance in the sector since May 2015. August move effectively demolished previous expectations of stabilisation in Manufacturing sector in Russia.

Per Markit release: "Operating conditions in the Russian manufacturing sector continued to deteriorate during August amid reports of a deterioration in the economic environment. Output was little changed, while new orders and employment both fell to the greatest degrees since May. Notably, a depreciation in the Russian rouble against the US dollar led to a sharp and accelerated increase in average input prices by raising the cost of imported goods. …The net effect was a decline in demand and a drop off in levels of incoming new business."

Meanwhile, Services PMI posted a disappointing decline from 51.6 in July to 49.1 in August, pushing the index below 50 mark once again. The index fell to its lowest level for the period covering last 5 months.

Per Markit: "The Russian service sector registered a slight fall in business activity during August as incoming new orders were barely changed and excess resources remained evident. Backlogs of work were again cut sharply, placing further downward pressure on staffing levels… Undermining service sector activity was a general lack of growth in incoming new business. Latest data showed that new work was only marginally higher, with companies bemoaning a lack of funds at clients amid evidence of a challenging economic environment.

With booth Manufacturing and Services down, Composite PMI for Russia fell below 50.0 marker in August, reaching 49.3 against 50.9 in August. This marks the second month in the last 3 months of sub-50 readings and August Composite PMI level is at the lowest levels since April 2015.

SUMMARY: As I noted consistently in the past, any sign of stabilisation in Russian economy coming on foot of disappointing 1H 2015 will require several confirmations before we can call a switch in the growth trend. This confirmation (on foot of July upside performance) did not arrive to-date.

28/8/15: CBR and Ruble: Fiscal Balance in Oil's Shadow

As I noted earlier this month, Russia has officially entered the recession. The key drivers for 3.4% contraction in 1H 2015 were the same as the key pressures on growth back in 2H 2014: oil prices, investment collapse on foot of high interest rates, inflationary environment that restricts CBR's room for cutting rates, and sanctions (or rather geopolitical risks and pressures, linked in part to sanctions).

That said, in June and early July there were some hopes for economy starting to stabilise, although fixed investment was down 7.1% y/y in June, marking 18th consecutive month of y/y declines. These are now once again under pressure and the cause is... oil price.

Here is how closely paired has Russian Ruble been to oil prices in trend terms since July 2014, although correlation was weaker in preceding period. Overall, as the chat shows, there are two very distinct periods of Ruble valuations catch up with oil prices: June 2014-February 2015 and mid-July 2015 through present.

Russia's Central Bank is switching between little concern for Ruble to interventions and back to staying out of the markets appears to be more than a simply random walk. Instead, it is a game consistent with rebalancing Ruble valuations to fit budgetary dynamics.

The reason for this is that (as shown in the chart above) Ruble strengthening above oil-linked fundamentals earlier this year was an actual threat to budgetary dynamics, and over the last couple of weeks, correcting valuations of Ruble re-established closer connection to oil prices. Hence, in July, CBR managed to deliver a shallower cut to interest rates (-50bps) compared to June (-100bps).

With CBR continuing to stick to its June 2016 forecast for inflation to fall to 'under 7%' by then and hit 4% in 2017 compared to July 2015 CPI at 15.6%, Russia went on to issue its first CPI-linked bonds / linkers amounting to RUB75 billion (OFZ-IN, 8 year notes) at 91% of nominal, on cover of RUB200 billion (more than 25% of demand coming from foreign investors). Real yield at issuance was 3.84% - relatively high-ish, implying underpricing of the bond in a market with relatively hefty demand and forward expectations for significant easing in inflation. Something is slightly amiss here.

In line with up-down interventions, the CBR continued to trend flat on foreign exchange reserves. End of June, total Russian FX reserves stood at USD361.575 billion, and by end of July these fell to USD357.626 billion. As of last week, the reserves were back up at USD364.6 billion.

Weekly data from CBR does not allow for compositional analysis of reserves, but looking at the monthly data the pattern repeats.

Actual liquid FX reserves and gold stood at USD347.1 billion at the end of July against USD350.957 billion at the end of June. This is barely up on end-April period low of USD345.373 billion, although well within the FX- and gold-valuations range of change.

Meanwhile, data through July 2015 shows net purchases of dollars of USD3.76 billion against USD3.831 billion in June and USD2.531 billion in May by CBR. Overall, from January 2015 through July 2015, CBR bought (net) USD7.8 billion and there were no net purchases/sales of euro.

All of the above suggests that CBR will likely resume rate cuts if Ruble firms up from its recent valuations. Two weeks ago, RUB/USD was at 64.947 (72.197 to Euro), peaking at 70.887 four days ago (82.373 to the Euro) and currently at 66.8875 (74.984 to Euro), not exactly warranting a move by the CBR yet, but back in the relative comfort zone for the Bank to sit on its hands once again.

15/8/15: Russian External Debt: Big Deleveraging, Smaller Future Pressures

Readers of this blog would have noted that in the past I referenced Russian companies cross-holdings of own debt in adjusting some of the external debt statistics for Russia. As I explained before, large share of the external debt owed by banks and companies is loans and other debt instruments issued by their parents and subsidiaries and direct equity investors - in other words, it is debt that can be easily rolled over or cross-cancelled within the company accounts.

This week, Central Bank of Russia did the same when it produced new estimate for external debt maturing in September-December 2015. The CBR excluded “intra-group operations” and the new estimate is based on past debt-servicing trends and a survey of 30 largest companies.

As the result of revisions, CBR now estimates that external debt coming due for Russian banks and non-financial corporations will be around USD35 billion, down on previously estimated USD61 billion.

CBR also estimated cash and liquid foreign assets holdings of Russian banks and non-bank corporations at USD135 billion on top of USD20 billion current account surplus due (assuming oil at USD40 pb) and USD14 billion of CBR own funds available for forex repo lending.

Here are the most recent charts for Russian external debt maturity, excluding most recent update for corporate and banks debt:

As the above table shows, in 12 months through June 2015, Russian Total External Debt fell 24%, down USD176.6 billion - much of it due to devaluation of the ruble and repayments of maturing debt. Of this, Government debt is down USD22.1 billion or 39% - a huge drop. Banks managed to deleverage out of USD59.9 billion in 12 months through June 2015 (down 29%) and Other Sectors external liabilities were down USD88.8 billion (-20%).

These are absolutely massive figures indicating:
1) One of the underlying causes of the ongoing economic recession (contracting credit supply and debt repayments drag on investment and consumer credit);
2) Strengthening of corporate and banks' balance sheets; and
3) Overall longer term improvement in Russian debt exposures.

6/8/15: IMF Assessment of Russian Banks & Financial Markets

Alongside the Article IV (covered in three posts all linked here: http://trueeconomics.blogspot.it/2015/08/3815-imf-on-russian-economy-private.html), the IMF also released a series of technical papers, including one on the state of health of the Russian financial markets.

Top-level conclusion: "using a comprehensive index of financial development, to identify potential bottlenecks", the study "…finds that Russia’s financial markets are relatively deep, accessible and efficient, but that financial institutions, in particular banks, have much to do to improve their efficiency and create further depth. Russia could potentially gain up to 1 percentage point in GDP growth on average over the medium-term from further deepening and efficiency improvements. Policies towards this outcome include reducing banking sector fragmentation through consolidation via increased supervision and tightening capital standards; strengthening the role of credit bureaus and collateral registries to reduce information asymmetries; and removal of interest rate rigidities to foster competition."

Specifically, one key bottleneck is the distribution of sources for finance: "Russian companies rely much less on external financing in general and on bank financing in particular, to finance investment compared to their peers in Eastern Europe and Central Asia or in their upper middle income group. Typically, internal resources, state funds and controlling entities are responsible for financing up to 80 percent of business investment. As a result, banks contribute only 6 percent of funding for business investment, with the bulk of investment financed from retained earnings."

Couple of charts

Now, one can agree with IMF on the need for Russian companies to tap more diversified investment channels, but one has to also observe two key risks inherent in this suggestion:

1. Debt levels overall are low in Russian economy, and much of these are accumulated in controlling entities relations with enterprises - in other words - linked to equity and direct investment. This is good, as this allows enterprises more flexibility and better management opportunities with respect to cash flow and business activity;
2. Low debt levels also allow for absorption of political shocks that we are witness gin today, arising from political shutting down of Russian companies access to Western funding markets. If Russia is to retain meaningful risk buffers, accessing external finance via bond markets and equity markets abroad saddles Russian entities with higher risk of external shocks.

So IMF can propose, but I seriously doubt Russian companies will be rushing to borrow at a breakneck speed any time soon.

IMF uses a relatively new framework for assessment of the financial sector environment, the concept of financial development. "Financial development is defined as a combination of:

• Depth (size and liquidity of markets), 
• Access (ability of individuals to access financial services), and 
• Efficiency (ability of institutions to provide financial services at low cost and with sustainable revenues, and the level of activity of capital markets)."

So IMF main conclusion is quite surprising for those not familiar with Russian markets: "Russia’s financial markets are relatively developed but financial institutions lag behind in terms of efficiency and depth."

"Russia’s FD index (0.58) is higher than the average EM (0.37) and slightly lower than the average BTICS (0.64), a group of countries composed of Brazil, Turkey, India, China, and South Africa. …Russia scores much higher than the comparator groups for FM developments [Financial Markets development] as it features higher degrees of access and efficiency in the operations of its financial markets. Although the depth of financial markets is slightly lower than BTICS countries, it remains much higher than the average EM."

Big bottleneck is in financial depth, where "…financial institutions in Russia are comparatively dominated by the banking system, with fewer to non-existent assets, in percent of GDP, in pension funds, mutual funds and insurance industry. Moreover, the banking system lacks depth with domestic credit at about 50 percent of GDP being the lowest in the BTICS group."

Why? "With some 850 banks operating, the Russian banking system is highly concentrated at the top, and fragmented at the bottom":

• "The top three banks (state-owned) accounted for more than 50 percent of total sector assets at year-end 2014 while the top 20 banks accounted for 75 percent of total sector assets."
• "Lending is highly concentrated among the top 10 bank groups making about 850 banks contribute only 15 percent of total lending."
• "…VTB Group alone with 16 percent share of lending accounts for a similar share as the 830 remaining banks."
• "Most of the banks are small and act as treasury accounts for local firms, operating in particular in mono-cities."

This "…undermines lending to companies and SMEs as their ability to both extend credit and diversify across companies is limited while lending to consumers is usually the dominant form of credit."

What is there to be done to get Russian banking and financial systems up to speed?

IMF benchmarks the potential scope of reforms against the absolute best scenario (not scenario consistent with other comparative economies), which makes things sound quite a bit optimistic, or unrealistic. The menu is predictable and relatively straightforward:

• Cut the number of banks without impacting degree of competition. Which is easy to say, hard to achieve, and at any rate, Russian authorities have been doing as much, albeit slowly, for a good part of almost 2 years now.
• Increase supervisory pressures to remove even more banks out of the active list (again, has been ongoing since 2013).
• Improve quality of collateral registries to lower the cost of collateralisation for SMEs. Which, in part, will also involve improving existent system of credit bureaus.
• Link deposit rates paid by the banks to the banks' deposit insurance cover. In other words, remove Central Bank restriction on deposit rates quoted by the banks, but replace it with a restriction capping ability of highly risky banks to raise uninsured deposits. Which sounds like a good idea, assuming deposit insurance scheme is fully funded and solvent. Which, in turn, assumes no systemic crisis.
• Privatise state banks. Which is strange. IMF also notes that "there is no urgent need in Russia for large scale privatization, especially in light of the fragmentary evidence that public banks in Russia are not less efficient than private ones." And the Fund stresses the importance of economies of scale in delivering improved banking sector efficiencies. Which begs a question: what is to be privatised? Large state-owned banks? If they are privatised with a break up, the system will suffer risks to the efficiency. If they are privatised as they are, the system will receive private dominant players in the market which, arguably, will be no different from the state-owned ones in any meaningful way.

As usual for IMF: neat pics, cool stats, a small pinch of useful proposals and a list of predictable ideas that make sense… only if you do not spot their faulty logic…

5/8/15: Russian Services & Composite PMIs: July 2015

Having covered Russian Manufacturing PMI for July here: http://trueeconomics.blogspot.ie/2015/08/3815-russia-manufacturing-pmi-july-2015.html, let's take a look at the today's Markit release of Services and Composite PMIs.

Services PMI rose to 51.6 in July compared to 49.5 in June, with new business activity reaching fastest growth in 20 months. On a 3mo average basis, sector performance through July was at 51.3 - showing a marginal rate of recovery, and a major improvement on 3mo average through April 2015 (at 46.0), as well as on 3mo average through July 2014 (48.5).

As chart above shows, Russian Services PMI posted above 50 readings in three out of last four months. However, by historical standards, this expansion is extremely weak.

Per Markit: "The Russian service sector returned to modest growth during July, with activity rising on the back of the strongest gain in new business for over a year-and-a-half. Still, excess capacity remained a problem, with companies again comfortably able to make inroads into their work outstanding despite cutting jobs for a seventeenth month in succession."

The decline in Manufacturing (see link above) meant that the Composite PMI for Russia was weaker than the Services PMI. Nonetheless, Composite PMI reached 50.9 in July, up on 49.5 in June. 3mo average through July is at 50.7 against 3mo average through April at 47.4 and 3mo average through July 2014 at 49.5. Just as with Services PMI, Composite PMI has now posted above 50 readings in three out of four last months.

The above suggests strengthening in the stabilisation and early recovery momentum in the Russian economy, albeit we need a rebound in Manufacturing to above 50.0 reading for a couple of months to confirm robustness of this development. While it does appear the Russian economy is now past the worst period of contraction, calling any recovery will require at least couple of more months of improvements in PMIs.

3/8/15: IMF on Russian Economy: Private Sector Debt

Continuing with IMF analysis of the Russian economy, recall that
- The first post here covered GDP growth projections (upgraded)
- External Debt and Fiscal positions (a mixed bag with broadly positive supports but weaker longer-term sustainability issues relating to deficits).

This time around, let's take a look at IMF analysis of Private Sector Debt.

As IMF notes, economic crisis is weighing pretty heavily on banks' Non-performing Loans:

In part, the above is down to hefty write downs taken by the banks on Ukrainian assets (Russian banks were some of the largest lenders to Ukraine in the past) both in corporate and household sectors.

However, thanks to deleveraging (primarily in the corporate sector, due to sanctions, and some in household sector, due to economic conditions), Loan to Deposits ratio is on the declining trajectory:

Note: Here is a chart on deleveraging of the corporate sector and for Russian banks:

In line with changes in demand for debt redemptions, FX rates, as well as due to some supports from the Federal Government, banks' exposure to Central Bank funding lines has moderated from the crisis peak, though it remains highly elevated:

Illustrating the severity of sanctions, corporate funding from external lenders and markets has been nil:

And Gross External Debt is falling (deleveraging) on foot of cut-off markets and increased borrowing costs:

So companies are heading into domestic markets to borrow (banks - first chart below, bonds - second chart below):

Net:

1) Corporate external debt is falling:

2) Household debt is already low:

3) But the problem is that deleveraging under sanctions is coinciding with economic contraction (primarily driven by lower oil prices), which means that Government reserve funds (while still sufficient) are not being replenished. IMF correctly sees this as a long term problem:

So top of the line conclusion here is that banking sector remains highly pressured by sanctions and falling profitability, as well as rising NPLs. Credit issuance is supported not by new capital formation (investment) but by corporates switching away from foreign debt toward domestic debt. Deleveraging, while long-term positive, is painful for the economy. While the system buffers remain sufficient for now, long term, Russia will require serious changes to fiscal rules to strengthen its reserves buffers over time.

3/8/15: IMF on Russian Economy: Debt Sustainability

In the previous post, I covered IMF latest analysis of Russian GDP growth. Here, another key theme from the IMF Article IV report on Russia: fiscal policy sustainability.

In its latest assessment of the Russian economy, IMF has reduced its forecast for General Government deficit for 2015, from -3.69% of GDP back in April 2015 to -3.3% of GDP in the latest report. However, in line with new Budgetary framework, the IMF revised its forecasts for 2016-2020 deficits to show poorer fiscal performance:

In line with worsening deficits from 2016 on, IMF is also projecting higher government debt (gross debt, inclusive of state guarantees):

Still, the IMF appears to be quite happy with the overall debt and fiscal sustainability over the short run and is taking a view that over the next 2-3 years, fiscal policy must provide some upside supports to investment.

One of the reasons for this is that IMF sees continued strong buffers on fiscal reserves side into 2020, with Gross international reserves of USD362.4 billion and 374.8 billion in 2015-2016 amounting to 13.6 months of imports and providing cover for 496% and 281% of short term debt, respectively.

Furthermore, IMF expects debt levels to remain benign, both in terms of Government debt and Private sector debt as the chart above shows.

Note: I will cover Private Sector Debt developments in a separate post, so stay tuned.

Overall, 

1) External debt situation remains positive and is improving in the sector with weaker performance (corporate sector):

Note: above figures do not net out debt written to Russian banks and corporates by their parent and subsidiary entities located outside Russia, as well as direct investment / equity -linked debt.

2) "...no sector shows maturity risk with short-term assets exceeding short-term debt in aggregate"

3) Fiscal stance appears to be expansionary, but moderate, with deficits below 4% of GDP forecast for the worst performance year of 2016.

4) "Exchange rate and liquidity risks are mitigated by the CBR's large reserve level"

Stay tuned for more analysis, including debt positions across various sectors.